Description

This is a recommendation to take a position in a small bank holding company in southern Nevada called Western Liberty Bancorp.  The symbol is WLBC and the market cap is 38 million. 

Western Liberty started out as a SPAC in 2007 to “identify for acquisition an operating company engaged in the consumer products and services business.”  (Despite this totally awesome strategy, early in 2009 they switched course and decided to buy a bank) The bank they decided to buy in 2010 (Service 1^st Bank of Nevada) currently has 23 million in nonperforming assets.  Loans measured for impairment, which included nonperforming loans as well as loans that continue to perform, but have some identified weakness, total 24.2 million – a whopping 24% of the loan portfolio!  Service 1^st was originally capitalized with 50 million in 2007.  They lost 4.2 million in 2007.  They lost 5.1 million in 2008.  They lost 17 million in 2009.  In 2010 Western Liberty lost 7.7 million.  They lost 14.9 million in 2011, largely the result of 8.7 million provision for loan losses and a 3^rd qtr non-cash charge of $5.6 million for goodwill impairment.

I know what you are thinking, this must be a short idea right?  Before reaching for that 6.3 rating you should note that I am recommending this as a…drum roll please..…a long idea!

How can that be?  In a nutshell:  A combination of excess capital at the bank and holding company level and a really cheap stock price.

Western Liberty has capital:  Tons of it when compared to the size of their loan portfolio.  Western Liberty has a Tier 1 Capital / risk-weighted asset ratio of 70.37%.  Of the approximately 200 million in assets, nearly half of that is cash or cash equivalents.  Their loan portfolio, after subtracting a loan loss provision, totals 98,771,000 and their equity is 80,673,000.  This is basically a bank not using much leverage.  Approximately 50% of their loan portfolio is CRE and approximately 40% is C&I.

Their stock is trading at 48% of tangible book value per share, with a market cap of 38 million. 

The Board of Western Liberty seems to agree that the stock is a buy.  From a press release dated December 6, 2011 announcing that the Board of Directors has authorized management to purchase up to 7% of its outstanding shares, after recently completing a 5% stock buyback:

“We continue to believe our stock is an attractive investment in light of our strong capital position,” stated Michael Frankel, Chairman.  “Share repurchases represent an efficient way to utilize capital, as the current share price is at a significant discount to tangible book value and under cash per share.”

When dealing with banks, due to their leveraged nature, it is not often that you see the phrase “trading below cash per share”  It is almost a nonsensical comment, unless the bank uses very little leverage.  In the 4^th quarter of 2011 they repurchased 934,987 shares at an average price of 2.34.  After booking a loss in the 4^th qtr of 2011, tangible book value (as a result of the buyback) increased to $5.60.

In addition to an aggressive stock buyback Western Liberty has recently engaged Sandler O’Neill as its financial advisor on strategic alternatives for maximizing value, which could “include a sale or other business combinations.” To expedite the resolution of non performing assets they formed a new wholly owned subsidiary called Las Vegas Sunset Properties and transferred $4.0 million in OREO and $11.5 million in NPLs from Service 1^st in January of 2012.  Service 1^st now has a ratio of classified assets to Tier 1 capital plus reserve of 48.4%.  I think this gets them closer to selling the bank, as it would make Service 1^st more attractive to an acquirer.

This situation reminds me of a demutualized insurer or bank, running an active buyback that is accretive to BVPS.  At the same time, my perception is that large institutional shareholders and management are eager to restore shareholder value – and I think the quickest way to do that is to sell the bank.  I think to some degree there is a put embedded in the stock created by the current buyback and possible buyback programs to follow.  I think the current portfolio has been written down to a point where loan losses and loan loss provisions should start tapering down.  I also think that the currency of would be suitors has increased dramatically in the beginning of 2012 as market volatility wanes and a lower risk aversion in the market entices some buying in larger regional banks.

The catalyst is or will be an acquisition.  The problem is that M&A in the small bank space is stagnant, and I can’t think of any ideal partners.  So that could take some time.  But by running an aggressive buyback while they wait, book value per share should start increasing as the portfolio losses taper off.  Like many small banks, I don’t think this one will exist in 5 years.  If we can get book value, or close to it, in the event of a sale - I think the IRR will be good and the excess capital should provide minimal downside from these prices.

Catalyst